Examples Of Publicized Risks
Market Risk:
1. In December 1994, Orange County’s Treasurer, Bob Citron, who was entrusted with a USD7.5 billion investment pool, invested a significant amount of money in derivative securities namely “structured notes” and inverse floaters” When interest rates rose, the rates on these derivatives securities declined along with the market value of those notes. This resulted in a USD1.7billion loss to the Orange County Investment Pool.
2. Gibson Greetings Inc. faced similar market risk during its aggressive purchasing of interest rate derivatives to take advantage of falling rates. When interest rates began to climb, Gibson sustained a USD20million loss on its derivative contracts.
3. Procter & Gamble’s (P&G) take a USD157million charge to unwind interest rate derivative contracts that were tied to interest rate in Germany and US. When the interest rates rose in both countries above the derivative’s contractual hurdle rate ( which required P&G to pay interest rates that were 412 basis points above the then commercial paper rate), the leverage derivatives became too costly for P&G.
4. In 2002, the Australian government’s bets on its own currency in the past five years. It went against them and may cost taxpayers as much as USD2.6billion. It predicted the currency to gain 11 per cent in 2001 but it fell 8.8 percent.
Credit Risk:
1. J.P.Morgan reclassified approximately USD600 million of its loans as “ non-performing” due to the crisis in Asia.
Liquidity Risk:
1. Askin Management lost USD600million in March 1994 due to its specialization into mortgage-backed debt instruments known on Wall Street as “toxic waste” because they carried the highest credit and interest rate risks. When interest rates rose sharply, trading in these debt instruments ceased. No market participants would quote Askin a price on their position anywhere near what they had paid. Kidder,Peabody & Co also lost USD25.5million, which it had loaned to Askin to leverage these positions.
Operational Risk:
1. A good example is the Barings case which occurred in February 1995. The immense losses were from unauthorized and hidden derivatives trading of an employee of Baring Futures Pte.Ltd in Singapore that went virtually undetected by management. The trader had been left unsupervised in his dual role as head of futures trading and head of settlements. The lack of segregation of duties within its operations, i.e. the bank’s failure to separate front and back office functions, created operational risk which resulted in irrecoverable losses and the eventual collapse of the firm.
2. Another example is the poor operational risk management and controls that led to an even bigger loss at Japan’s Daiwa Bank Ltd in the bond market. In 1995, it was discovered that a bond trader at Daiwa was able to conceal approximately $1billion in trading losses because of his access to the bank’s accounting books. There was no segregation of duties and the trader was in control of accounts as well as trading activities.
(Source:MIA)